Tag Archives: Freddie Mac

State of the Nation’s Housing Finance

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The Joint Center for Housing Studies of Harvard University has released the 2014 edition of The State of the Nation’s Housing. As to the nation’s housing finance system, the report finds that

The government still had an outsized footprint in the mortgage market in 2013, purchasing or guaranteeing 80.3 percent of all mortgages originated. The FHA/VA share of first liens, at 19.7 percent, was well above the average 6.1 percent share in 2002–03, let alone the 3.2 percent share at the market peak in 2005–06. Origination shares of Fannie Mae and Freddie Mac were also higher than before the mortgage market crisis, but less so than that of FHA. According to the Urban Institute’s Housing Finance Policy Center, the GSEs purchased or guaranteed 61 percent of originations in 2012 and 2013, up from 49 percent in 2002 and 2003.

Portfolio lending, however, has begun to bounce back, rising 8 percentage points from post-crisis lows and accounting for 19 percent of originations last year. While improving, this share is far from the nearly 30 percent a decade earlier. In contrast, private-label securitizations have been stuck below 1 percent of originations since 2008. Continued healing in the housing market and further clarity in the regulatory environment should set the stage for further increases in private market activity. (11)

As usual, this report is chock full of good information about the single-family and multi-family sectors. I did find that some of its characterizations of the housing market were lacking. For instance, the report states

Many factors have played a role in the sluggish recovery of the home purchase loan market in recent years, including falling household incomes and uncertainty about the direction of the economy and home prices. But the limited availability of mortgage credit for borrowers with less than stellar credit has also contributed. According to information from CoreLogic, home purchase lending to borrowers with credit scores below 620 all but ended after 2009. Since then, access to credit among borrowers with scores in the 620–659 range has become increasingly constrained, with their share of loans falling by 6 percentage points. At the same time, the share of home purchase loans to borrowers with scores above 740 rose by 8 percentage points.

Meanwhile, the government sponsored enterprises (GSEs) have also concentrated both their purchase and refinancing activity on applicants with higher credit scores. At Fannie Mae, only 15 percent of loans acquired in 2013 were to borrowers with credit scores below 700—a dramatic drop from the 35 percent share averaged in 2001–04. Moreover, just 2 percent of originations were to borrowers with credit scores below 620. The percentage of Freddie Mac lending to this group has remained negligible.

Yet another drag on the mortgage market recovery is the high cost of credit. For borrowers who are able to access credit, loan costs have increased steadily. To start, interest rates climbed from 3.35 percent at the end of 2012 to 4.46 percent at the end of 2013. This increase was tempered somewhat by a slight retreat in early 2014. In addition, the GSEs and FHA raised the fees required to insure their loans after the mortgage market meltdown, and many of these charges remain in place or have risen. The average guarantee fee charged by Fannie Mae and Freddie Mac jumped from 22 basis points in 2009 to 38 basis points in 2012. In 2008, the GSEs also introduced loan level price adjustments (LLPAs) or additional upfront fees paid by lenders based on loan-to-value (LTV) ratios, credit scores, and other risk factors. LLPAs total up to 3.25 percent of the loan value for riskier borrowers and are paid for through higher interest rates on their loans. (20)

Implicit in this analysis is the view that lending should return in some way to its pre-bust levels. But, in fact, much of the boom lending was unsustainable for many borrowers. The analysis fails to identify the importance of promoting sustainable homeownership and instead relies on one dimensional metrics like credit denials for those with low credit scores. Until we are confident that borrowers with those scores can sustain homeownership in large numbers, we should not be so quick to bemoan credit constraints for people with a history of losing their homes to foreclosure.

The Center’s analysis also takes a simplistic view about guarantee fees.  The relevant metric is not the absolute size of the g-fee. Rather, the issue should be whether the g-fee level achieves its goals. At a minimum, those goals include appropriately measuring the risk of having to make good on the guarantee.

Finally, the Center demonstrates symptoms of historical amnesia when it characterizes an interest rate of 4.46% as “high.” This is an incredibly low rate of interest and one would expect that rates would rise as we exit from the bust years.

I have made the point before that the Center’s work seems to reflect the views of its funders. The funders of this report (not identified in the report by the way) include the National Association of Home Builders; National Association of Realtors; National Housing Conference; National Multifamily Housing Council; and a whole host of lenders, builders and companies in related fields that make up the Center’s Policy Advisory Board. These organizations benefit from a growing housing sector. This report seems to reflect an unthinking pro-growth perspective. It would have benefited from a parallel focus on sustainable homeownership.

Reiss on Rising Interest Rates

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ABC News quoted me in Small Interest Rate Changes Mean Big Money for Home Buyers.  The story reads in part,

As the economy continues to recover from the worst recession since the 1930s, mortgage interest rates remain at historically low levels.

The Primary Mortgage Market Survey, produced by Freddie Mac, reported in mid-March the average rate for 30-year fixed-rate mortgages was 4.32 percent; 15-year fixed-rate mortgages averaged 3.32 percent and interest rates 5-year Treasury-indexed hybrid adjustable rate mortgages averaged 3.02 percent. Nonetheless, Frank Nothaft, chief economist for Freddie Mac, speculated the Fed’s gradual tapering of its stimulus efforts may prompt a rise in mortgage interest rates.

If mortgage interest rates do rise significantly in the future, what, if any effect will there be on the home buying market? According to Steve Calk, chairman and Chief Executive Officer of The Federal Savings Bank, interest rates have never been the deciding factor for whether potential home buyers actually purchase a home.

“Whether interest rates are 5.5 percent or 7.5 percent, when people are ready to buy, they’ll buy a home,” Calk said.

Price, location, size, appreciation value – these are factors many would-be homeowners consider long before mortgage interest rates enter into the picture. However, once they begin actively searching for a home, interest rates often play a role in their ultimate buying decision.

This is especially the case when interest rates are high, according to David Reiss, Professor of Law at Brooklyn Law School.

“When people think about buying houses, they think about the price of the house. But what they really should be thinking of are the monthly costs. The average 25-year-old might not think about housing rates until they go to a mortgage broker.
“Then they discover that 8 percent interest may mean that instead of a $200,000 home they can only afford a $160,000 home,” Reiss said.

*     *      *

Tight credit and persistent high unemployment have almost certainly played a role in depressing home buying figures during the recovery, as has the large numbers of home owners who perhaps bought homes at the height of the bubble who now find themselves underwater on their mortgages. However, many underwater homeowners could be missing out on a unique opportunity presented by the present financial climate. In a housing market where prices are depressed and borrowing is cheap, home buyers with solid incomes and good credit can find lenders willing to extend credit on favorable terms, ultimately putting them ahead financially, even if they sell their present homes at a loss, according to Reiss.

“Many people feel stuck in place because they are underwater or the market is bad. But although it may be counterintuitive, it could actually be a smart move to sell in a bad market. It’s a bit more sophisticated strategy, but you could move out of a cheap home into a better home for not that much money,” Reiss said.

*     *     *

Education and due diligence in maintaining good credit are the most potent tools that potential home buyers can employ, whether they are seeking their first home, a larger home or are scaling down to smaller quarters as empty nesters. Obtaining prequalification can provide home seekers with a better idea of precisely how much house they can afford, Reiss said.

Reiss on Fannie and Freddie Conservatorship Litigation

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I have posted An Overview of the Fannie and Freddie Conservatorship Litigation to  SSRN (and to BePress as well). The abstract reads:

The fate of Fannie Mae and Freddie Mac are subject to the vagaries of politics, regulation, public opinion, the economy, and not least of all the numerous cases that have been filed in 2013 against various government entities arising from the placement of the two companies into conservatorship. This short article will provide an overview of the last of these. The litigation surrounding Fannie and Freddie’s conservatorship raises all sorts of issues about the federal government’s involvement in housing finance. These issues are worth setting forth as the proper role of these two companies in the housing finance system is still very much up in the air. The plaintiffs, in the main, argue that the federal government has breached its duties to preferred shareholders, common shareholders, and potential beneficiaries of a housing trust fund authorized by the same statute that authorized their conservatorships. At this early stage, it appears that the plaintiffs have a tough row to hoe.

Appraisals in the Coal Mine

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The Federal Housing Finance Agency Office of Inspector General released an Audit Report, FHFA’s Oversight of the Enterprises’ Use of Appraisal Data Before They Buy Single-Family Mortgages. As the IG notes,

Assessing the value of collateral securing mortgage loans is one of the pillars in making sound underwriting decisions. Since September 2008, the Federal Housing Finance Agency (FHFA) has operated Freddie Mac and Fannie Mae (the Enterprises) in conservatorship, due to poor business decisions and risk management that led to enormous losses. While in conservatorship, the Enterprises have relied on Treasury’s financial support to operate in the secondary mortgage market, buying loans in order to provide needed liquidity to lenders. In 2010, FHFA directed the Enterprises to improve single-family residential loan quality and risk management through, among other things, developing a uniform collateral data portal (portal).

Unfortunately, the IG found that

  • from January 2013 through June 2013, Fannie Mae spent $13 billion buying over 56,000 loans even though the portal’s analysis of the associated appraisals warned the Enterprise that the appraisals were potentially in violation of its underwriting requirements.
  • from June 2013 through September 2013, Freddie Mac spent $6.7 billion buying over 29,000 loans despite the portal warning the Enterprise that either no property value could be provided or the value of the property was in question.

  • the Enterprises bought nearly $88 billion in loans when system logic errors in the portal did not allow them to determine if the appraiser was properly licensed to assess the value of the properties, which served as collateral for the loans.

The IG did not characterize these problems as particularly worrisome, but I wonder if they are somewhat symbolic of the limbo state that the Enterprises find themselves in. Like canaries in a coal mine, they alert us to a serious problem.

Neither private companies nor government instrumentalities, the Enterprises must stagger on until the federal government decides what to do with them. Let’s hope that the Enterprises are not silently building up to another crisis, one not driven by the profit-motive as the last one was, but driven by bureaucratic incompetence. “Bureaucratic” in the sense of the “rule of no one,” as Mary McCarthy defined it.

Fannie and Freddie’s current profitability should not be used as an excuse to delay reform further. They are too important to have been left in limbo for so long.

 

Reiss on Marketplace: Cash Cows to Slaughter

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I was interviewed on Marketplace for its story, Fannie and Freddie: Cash Cows Avoid The Slaughter? (sound file) The text of the story reads

We are making money – the tax payer, that is – on Fannie and Freddie Mac.

When Freddie Mac hands the treasury a $10.4 billion dividend next month, tax payers will have received more money in interest than was put in. (Technically the two institutions still owe the principal on the loan that bailed them out, but the interest they’re paying will shortly exceed that amount).

But.

There always is a but with these things.

Making money for the tax payer isn’t good if you ask those who want reform.

Back during the financial crisis, conservatives and liberals disagreed over whether Freddie and Fannie were a victim of or a cause of the housing collapse, but they agreed that the institutions needed reform. The profits are throwing a wrinkle into this debate.

“As long as Fannie and Freddie continue to pay substantial amounts of money to the government, they are looked at by some people in Congress as a great source of revenue that reduces the deficit,” explains Peter Wallison with the American Enterprise Institute. His concern – shared by reformers on both sides of the political spectrum – is that if Fannie and Freddie become cash cows, congress won’t want to touch them.

David Reiss, professor of law at the Brooklyn Law School, agrees. He says the financial crisis wasn’t a one time problem.

“We should think of it as that we dodged a bullet. There’s fundamental problems with the Fannie and Freddie business model which rests on this notion of privatizing profits and socializing losses.”

Freddie and Fannie buy mortgages from lenders, and then bundle them into “mortgage backed securities” that can be sold to investors. It’s useful because it converted illiquid mortgage loans into liquid securities. In plain English, it means a bank or investor who made a mortgage loan to someone didn’t have to wait around for 30 years to be paid back. They could sell their stake in the mortgage to Fannie or Freddie, move along, and go invest in other things. This helped more people get mortgages.

One concern was that Fannie and Freddie were simply too big and too concentrated. Another concern was that the federal government implicitly guaranteed investments in Freddie and Fannie, and that encouraged people to make home loans that were too risky.

Even without the complication of profits, the debate over how to reform Fannie and Freddie is at a stand still.

House Republicans don’t want the government involved at all, they want an efficient market. The Senate wants the government to be involved a little bit, essentially to promote housing.

“What I see,” says David Reiss, “is nothing really happening, and us being a holding pattern for a long time.”

It’s possible that reform-minded politicians will compromise before they lose their chance. Also possible they won’t.

FIRREA Does the Hustle

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Judge Rakoff has issued another Opinion in U.S. v. Countrywide Fin. Corp. et al., 12 Civ. 1422 (Feb. 17, 2014).  Rakoff reconfirms his broad reading of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which covers fraudulent behavior that is self-affecting; that is, where the perpetrator and victim of the fraud are one and the same financial institution. This Opinion goes further, however, based on on developments in the litigation since that earlier opinion.

The Opinion notes that the defendants were found liable at trial and finds that

Based on the charge as given to the jury, the jury, by finding liability, necessarily found that the defendants intentionally induced two government-sponsored entities, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), to purchase from the Bank Defendants thousands of loans that Fannie Mae and Freddie Mac would not otherwise have purchased. The defendants did so, the jury necessarily found, by misrepresenting that the loans they were selling were “investment quality” and that they knew of nothing that might cause investors to regard the mortgages as poor investments, when in fact the defendants knew that their underwriting process, known as the “High Speed Swim Lane,” “HSSL,” or “Hustle,” was calculated to produce loans that were not of investment quality. (3)

The Court had previously found that “the fraud here in question, perpetrated by the Countrywide defendants and Ms. Mairone, had a huge effect on Bank of America defendants, which, as a result of Bank of America’s purchase of Countrywide, paid, directly or through affiliates, billions of dollars to settle repurchase claims brought by Fannie Mae and Freddie Mac.” (4) The opinion concludes that

It is highly improbable that Congress would have intended to place beyond the reach of FIRREA those defendants whose misconduct “affects” federally insured banks that have the great fortune to be fully insured [by their affiliates] for such losses. Even less so can it be imagined that the device of having BAC [the BoA parent holding company] indemnify BANA [the BoA federally insured bank] for losses that otherwise would result from Countrywide’s fraud immunizes Countrywide from liability under FIRREA. Indeed, defendants’ labeling of this theory of liability as the “self-affecting” theory is something of a misnomer; Countrywide’s fraud, which culminated before the merger with BANA, directly affected, not just Countrywide, but its merger partner, BANA, as well. While the effect on Countrywide might be “self-affecting,” the effect on BANA was not. (5)

This Opinion seems to bolster Rakoff’s broad reading of FIRREA.  As of now, FIRREA gives the federal government a powerful tool to pursue alleged wrongdoing affecting federally insured financial institutions.  The caselaw reads FIRREA broadly and the statute’s ten-year statute of limitations means that additional suits may still be coming down the pike.

Federalizing Monoline Mortgage Insurance

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The Federal Insurance Office of the Department of Treasury issued a report required pursuant to Dodd-Frank, How To Modernize And Improve The System Of Insurance Regulation In The United States, which addresses among other things the state of the monoline mortgage insurance industry:

Recommendation: Federal standards and oversight for mortgage insurers should be developed and implemented.

Like financial guarantors, private mortgage insurers are monoline companies that experienced devastating losses during the financial crisis. A business predominantly focused on providing credit enhancement to mortgages guaranteed by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, mortgage insurers migrated from the core business of insuring conventional, well-underwritten mortgage loans to providing insurance on pools of Alt-A and subprime mortgages in the years leading up to the financial crisis. The dramatic decline in housing prices and the impact of the change in underwriting practices required mortgage insurers to draw down capital and reserves to pay claims resulting in the failure of three out of the eight mortgage insurers in the United States. Historically high levels of claim denials, including policy rescissions, helped put taxpayers at risk.

Regulatory oversight of mortgage insurance varies state by state. Though mortgage insurance coverage is provided nationally, only 16 states impose specific requirements on private mortgage insurers. Of these requirements, two govern the solvency regime and, therefore, are of particular significance: (1) a limit on total liability, net of reinsurance, for all policies of 25 times the sum of capital, surplus, and contingency reserves, (known as a 25:1 risk-to-capital ratio); and (2) a requirement of annual contributions to a contingency reserve equal to 50 percent of the mortgage insurer’s earned premium. In addition to the states, the GSEs (and through conservatorship, the Federal Housing Finance Agency) establish uniform standards and eligibility requirements that in some cases are more stringent than those required by state regulators. As the financial crisis unfolded, mortgage insurers no longer met state or contractual capital requirements. State regulators granted waivers in order to allow mortgage insurers to continue to write new business while the GSEs loosened other standards that were applicable to mortgage insurers.

The private mortgage insurance sector is interconnected with other aspects of the federal housing finance system and, therefore, is an issue of significant national interest. As the United States continues to recover from the financial crisis and works to reform aspects of the housing finance system, private mortgage insurance may be an important component of any reform package as an alternative way to place private capital in front of any government or taxpayer risk. Robust national solvency and business practice standards, with uniform implementation, for mortgage insurers would help foster greater confidence in the solvency and performance of housing finance. To achieve this objective, it is necessary to establish federal oversight of federally developed standards applicable to mortgage insurance. (31-32)

This critique of the monoline insurance industry seems accurate to me. The industry has a tendency to fail when it is needed most — during major financial crises. Having multiple states regulate monoline insurers allows this nationally (and globally) significant industry to engage in regulatory arbitrage — that is, finding the most pliable regulatory environment in which to operate. National regulation would solve that problem. As always, a single federal regulator is more prone to capture by the industry it regulates than a bunch of state regulators. We have, however, tried the alternative and it has not worked so well. I think a federal approach is worth a try.